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What Is Systemic Risk? Moral Hazard, Initial Shocks, and Propagation

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  • Dow, James

    (London Business School)

Abstract

This paper discusses different aspects of the notion of systemic risk. It contains a selective survey of the research on related topics, a review of some case studies of financial crises and failures, and a discussion pointing toward the importance of moral hazard as a key element of systemic risk. The main ideas studied are the links between capital structure theory and bank capital regulation, and moral hazard and agency theory at the level of the individual trader, the financial firm, and the overall financial system. Another important idea is the co- determination of asset prices and bank solvency. My main focus is on moral hazard as a potentially fruitful area for future research. Although existing research emphasizes the powerful propagation mechanisms whereby a small initial shock can be amplified by the financial system, I suggest that moral hazard, together with leverage at the level of the individual firm, can cause a large shock to the financial system.

Suggested Citation

  • Dow, James, 2000. "What Is Systemic Risk? Moral Hazard, Initial Shocks, and Propagation," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 18(2), pages 1-24, December.
  • Handle: RePEc:ime:imemes:v:18:y:2000:i:2:p:1-24
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    File URL: http://www.imes.boj.or.jp/research/papers/english/me18-2-1.pdf
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    Cited by:

    1. Martin Summer, 2003. "Banking Regulation and Systemic Risk," Open Economies Review, Springer, vol. 14(1), pages 43-70, January.
    2. Gianni De Nicolo & Myron L. Kwast, 2002. "Systemic Risk and Financial Consolidation; Are they Related?," IMF Working Papers 02/55, International Monetary Fund.
    3. De Nicolo, Gianni & Kwast, Myron L., 2002. "Systemic risk and financial consolidation: Are they related?," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 861-880, May.
    4. Zigrand, Jean-Pierre, 2014. "Systems and systemic risk in finance and economics," LSE Research Online Documents on Economics 61220, London School of Economics and Political Science, LSE Library.
    5. Instefjord, Norvald, 2005. "Risk and hedging: Do credit derivatives increase bank risk?," Journal of Banking & Finance, Elsevier, vol. 29(2), pages 333-345, February.
    6. Bholat, David & Gray, Joanna, 2013. "Organizational form as a source of systemic risk," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 7, pages 1-35.
    7. Eboli, Mario, 2013. "A flow network analysis of direct balance-sheet contagion in financial networks," Kiel Working Papers 1862, Kiel Institute for the World Economy (IfW).
    8. Blum, Jurg M., 2002. "Subordinated debt, market discipline, and banks' risk taking," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1427-1441, July.
    9. Terri Bradford & Matt Davies & Stuart E. Weiner, 2002. "Nonbanks in the payments system," Payments System Research Working Paper PSR WP 02-02, Federal Reserve Bank of Kansas City.
    10. Michael Boss & Helmut Elsinger & Martin Summer & Stefan Thurner, 2004. "Network topology of the interbank market," Quantitative Finance, Taylor & Francis Journals, vol. 4(6), pages 677-684.
    11. WeiƟ, Gregor N.F. & Bostandzic, Denefa & Neumann, Sascha, 2014. "What factors drive systemic risk during international financial crises?," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 78-96.
    12. Lehar, Alfred, 2005. "Measuring systemic risk: A risk management approach," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2577-2603, October.
    13. Kole, Erik & Koedijk, Kees & Verbeek, Marno, 2006. "Portfolio implications of systemic crises," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2347-2369, August.

    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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